Cap and dividend

One intriguing form of carbon pricing that is being bandied about is the ‘tax and dividend’ approach. The idea is this: everybody pays a carbon tax on fuels and emitting activities. All the money is collected in a fund and redistributed evenly back to all taxpayers. As such, anyone who buys emits more than the mean quantity of carbon becomes a net payer and everyone who emits less actually gets back more than they pay. As mean emissions fall, so does the equivalence level of emissions – the point where you get back exactly what you paid.

For example, let’s imagine a tax that starts at a relatively modest $20 per tonne of carbon dioxide equivalent (CO2e). The mean Canadian produces about 23 tonnes of carbon a year, meaning they would pay $460 in carbon tax that year. That being said, the mean Canadian would also get back $460 as a dividend. A Canadian who is really trying (not flying, not eating meat, living in an efficient home, not driving, etc) might have much more modest emissions: say, 6 tonnes a year. They would pay $120 in carbon taxes and get back $460 – a nice ‘thank you’ for living a life that does less harm to others. Of course, someone who flies trans-Atlantically several times a year might end up paying significantly more in tax than they get back as a dividend.

Now say it is ten years on. The price of carbon has risen to $50 per tonne of CO2e and mean emissions per person have fallen by 25%. The break-even point is now 17.25 tonnes of carbon. As a result, someone who has not changed their lifestyle is now paying (23 – 17.25) * $50 or $287.50 a year in carbon taxes. If the 6 tonne person also managed a 25% cut, they would be earning (17.25 – 4.5) * $50 or $637.50 more in dividends than they paid in taxes.

These numbers are purely illustrative. It is possible that the per-tonne carbon taxes could be lower, and also possible that they would need to be much higher. In whatever case, the structure of the approach should be clear.

The approach has much to recommend it. For one, it is likely to enjoy the support of those already living relatively green lifestyles. For another, it has similar incentive effects to other carbon pricing schemes. It would encourage people to minimize or forego things with a heavy carbon burden, as well as make them more willing to invest in capital and technology that will reduce their carbon footprint.

I think the problem with any tax or offsetting scheme is it sends the message that if you have the money you can buy your way out. Granted that is the general message being sent now about a lot of things (Justice and the OJ Simpson case, current EPA/EC fines that are “just a cost of doing business”. )

The problem with this scheme is that you hit the consumer directly with the tax and then you hit the corporations, who might “pay” the cost but in reality will only pass on the expense to the consumer in the form of higher prices for goods, meaning you are lowering net disposable income and raising inflation, a sure recipe for economic disaster.

I know eventually the feedback look will go full circle and the consumer will vote with his dollar and support green companies, but that does take a long time and for some things demand is relatively inelastic.

One advantage of the system above is that it is very transparent to the consumer. They can very easily approximate what effect it will have on them and, while they might disagree with the ethical principle, they can at least see a clear ethical principle being applied.

This idea could really cut opposition to a carbon tax. Nobody could accuse the government of making a tax grab, because they could just multiply their own dividend by the number of taxpayers and see that all the money is being recycled.

As an aside, should it be all taxpayers, all residents, or all citizens who get dividends?

The easiest way to manage it would be to tax energy sources at their point of production or entry into the country and tax process emissions at the same two places.

That way, oil produced in Alberta and refined in Ontario would get taxed for carbon content at the Alberta well-head and taxed for emissions associated with refining in Ontario. Naturally, the taxes would be passed to consumers.

It is much trickier when you are talking about plastic being imported from China, but some system could still be devised.

Starting with the emission sources that are easiest to track makes sense. Producing a globally aware system will take longer, though it would be easy to apply the wellhead tax to any fuels we are importing.

Disposal is also a somewhat separate matter. It does make sense to charge households the full cost (at least, since there are other externalities) of running landfills. If garbage is being incinerated, a carbon tax should also be applied.

This would probably have the effect of being broadly redistributive, since the poor are often unable to afford cars or foreign holidays and therefore often live relatively low carbon lives. In a period where income and wealth inequalities have generally been rising, this is probably a good thing (or at least it means these measures may command the support of those who think greater income and wealth equality is a good thing).
On the other hand, it would likely be regarded as an attack on rural communities at the expense of urban dwellers insofar as rural areas often mean long car journies or lots of flights. The system would need to be designed in such a way that it wouldn’t penalise those in poor, remote communities or dissaude governments and companies from providing them with services (eg. you don’t want to dissaude people from flying needed medical specialists or patients to or from remote reserves). Unless those kind of issues were factored in from the start (perhaps by excluding any necessary government services such as policing and healthcare from the system) then there might be a great deal of opposition from various sources. Or would aboriginal people be exempt anyway (since they have a unique status re. taxation etc)?

Cap and dividend is a simple, market-based way to reduce CO2 emissions without reducing household incomes. It caps fossil fuel supplies, makes polluters pay, and returns the revenue to everyone equally.

I should preface by saying that I am a fan of Peter Barnes. He’s an emeritus board member of Redefining Progress. He’s a smart and thoughtful guy. But I’m not a fan of his cap and dividend idea, mostly from an economic perspective.

First, the idea that a price on carbon would be transformative, and that we should do that first and then come in with other complementary policies later, is dangerously wrong. Transportation and building heating/electricity are the two largest contributors to carbon emissions, accounting for well over half the total. The price elasticity on transportation fuels is very low, as we’ve seen. With gas prices up $2 per gallon in the last three years, we’re now finally seeing small reductions in driving, somewhere in the neighborhood of 4%. $2 per gallon of gas is roughly the equivalent of $200 per ton of carbon, a price impact that the failed Lieberman Warner bill wouldn’t have brought until beyond 2040, if then.

We’ve written a bit about cap-and-dividend: it’s a variety of cap and trade in which 100 percent of the program’s revenue is returned on a per capita basis. It has the pretty terrific effect of simultaneously limiting carbon and advancing equity. Like a climate version of the Alaska Permanent Fund Dividend, it would give people a stake in the program’s success.

Now it appears that there’s a tax-and-dividend movement gaining steam. As Andrew Revkin points out in the NY Times environment blog, conservative columnist John Tierney and ur-climate scientist James Hansen are both proposing carbon taxes with a full rebate from the proceeds. They’re in the company of researchers at the RAND corporation. In the Northwest, the conservative Washington Policy Center has made a similar proposal (a small carbon tax that would offset the state sales tax). And of course, the best example of a tax-and-dividend-esque policy is British Columbia’s new carbon tax shift.

On the other hand, it would likely be regarded as an attack on rural communities at the expense of urban dwellers insofar as rural areas often mean long car journies or lots of flights.

Again, this goes back to the entitlement issue. People do not have an unrestricted right to keep on living as they have been. If rural communities can adapt to low carbon lives, more power to them. If it is painful and expensive, that is regrettable but still necessary.

Or would aboriginal people be exempt anyway (since they have a unique status re. taxation etc)?

This is an interesting moral and legal question. I cannot think of a good answer right now.

Note: the above post would be more accurately called tax-and-dividend.

In a cap-and-dividend approach, government would choose a total level of emissions and then sell or otherwise distribute permits for that quantity. That would, in turn, cause buyers of permits (energy generators, manufacturers, etc) to raise their prices for consumers. In many ways, the effects would be similar to a tax-and-dividend approach.

Americans have an average carbon footprint of 24 tons per year. As a thought experiment, imagine I offered you the following deal: every year, I’ll charge you $2,000 per ton of your personal emissions. I’ll also offer you a guaranteed $48,000 annual rebate. Would you take the deal?

I bet most Americans would. Think about the behavioral changes that would follow. Every gallon of gas now costs you about $20. Of course, you’ll be able to afford it because I’m handing you a huge check every year. But that Prius is starting to look a lot more attractive, to say nothing of your bicycle. A single cross-country flight is now going to set you back about $2,500. Again, you can swing the expense. But is there something else you’d rather spend $2,500 on? Maybe it’s really important for you to spend Christmas with your family. Or maybe you can send them an e-card.

A carbon-use dividend for everybody must replace the old, ineffectual ‘cap-and-trade’ scheme

Last weekend’s minimalist Copenhagen global climate accord provides a great opportunity. The old deceitful, ineffectual approach is severely wounded and must die. Now there is a chance for the world to get on to an honest, effective path to an agreement.

The centrepiece of the old approach was a “cap-and-trade” scheme, festooned with offsets and bribes – bribes that purportedly, but hardly, reduced carbon emissions. It was analogous to the indulgences scheme of the Middle Ages, whereby sinners paid the Church for forgiveness.

In today’s indulgences the sinners, developed countries, buy off developing countries by paying for “offsets” to their own emissions and providing reparation money for adaptation to climate change. But such hush money won’t work. Yes, some developing country leaders salivated over the proffered $100 billion per year. But by buying in, they would cheat their children and ours. Besides, even the $100 billion hush money is fugacious. The US, based on its proportion of the fossil fuel carbon in the air today, would owe $27 billion per year. Chance of Congress providing that: dead zero. Maybe the UK will cough up its $6 billion per year and Germany its $7 billion per year. But who will collect Russia’s $7 billion per year?

Most purchased “offsets” to fossil fuel carbon dioxide emissions are hokey. But there is no need to flagellate the details of this modern indulgences scheme. Science provides an unambiguous fact that our leaders continue to ignore: carbon dioxide from fossil fuel burning remains in the climate system for millennia. The only solution is to move promptly to a clean energy future.

“But now comes a new idea, or at least an amalgam of old ideas that makes it seem new, and this might break the logjam in Congress. Properly studied and adapted to different circumstances, it could provide a jolt of new thinking for the Harper government, assuming this government wishes to do any thinking about a subject it dislikes.

The idea, from Democratic Senator Maria Cantwell of the state of Washington, is for a cap-and-dividend system, whereby an annual cap would be placed on emissions from coal, oil and natural gas sources. The cap would gradually fall each year. The permits to pollute would be traded, with a fixed price known in advance.

The bulk of the revenue from the yearly auction, however, would be returned to consumers to compensate them – and, in some cases, to overcompensate them – for the higher prices that fuel companies would pass on after buying the polluting credits.

Seventy-five per cent of the yearly revenues would be sent to consumers, with a family of four receiving $1,000. The rest would be placed in a trust fund to be spent on further emissions reductions, technology research and development.

You can easily see the potential political attractiveness of the cap-and-dividend scheme, in that families would get a cheque in the mail every year – something the Harper government already does with its family credit that is laughably supposed to be a child-care policy. You can see another attractive angle, in that the cap-and-dividend scheme targets only upstream polluters.”

“[T]here is no readily apparent alternative [to cap-and-trade] that would be any easier politically. It is difficult to imagine a globally harmonized carbon tax.”

This is dreadfully wrong, both substantively and politically.

Mr. Gore’s substantive error lies in presuming that a cap-based approach could be harmonized globally. Perhaps this is a legacy of his having championed cap-and-trade in the 1997 negotiations that produced the Kyoto Protocol. Yet now, as then, there are no clear grounds for translating a possible U.S. cap on carbon emissions into limits for other countries. Per capita, Americans generate 4 times as much greenhouse gases as Chinese and 14 times as much as Indians. Why, then, should a U.S. commitment to reduce emissions by, say, 2 percent a year, carry any moral authority in China or India? Indeed, India’s per capita emissions could increase by 2 percent a year for more than 60 years and still not match U.S. emissions declining at the same rate.

A carbon tax, in contrast, is wholly fungible across borders. A fee that raises the price of coal or natural gas by so much in one country will do the same in another. If one country is more efficient in turning energy into goods and services, or enjoys a greater abundance of carbon-free water- or wind-power, then that is an incentive to other nations to step up their efforts and achieve parity. A carbon tax thus creates no unfair comparative advantage. While these facts can’t guarantee global harmonization of a carbon tax, they provide a strong basis for it.

Politically, Mr. Gore’s dogged support of cap-and-trade sounds tone-deaf. The financial crisis hasn’t merely shaken the world’s confidence in market-based solutions; it has provoked a profound revulsion among Americans against financial speculation, market manipulation and legislative complexity. Yet all of these are intrinsic to cap-and-trade systems built on trillion-dollar markets in volatile emission permits. It is this political reaction, even more than media-driven denial of climate science, that has turned Congress against cap-and-trade. Mr. Gore underestimates its staying power at his own risk.

There is an alternative to both cap-and-trade and inaction, and it is the very instrument that Al Gore bravely backed for almost two decades: a carbon tax. This is not a market-based approach to be administered by Wall Street insiders, but an incentives-based one applied to all fossil fuels by the U.S. Government. With the revenues redistributed to Americans as monthly carbon checks and the tax rebranded as a carbon fee—as proposed by Mr. Gore’s climate mentor, climatologist James Hansen—a carbon “fee-and-dividend” would be everything cap-and-trade cannot: simple, transparent, effective and, above all, equitable.

With fee-and-dividend, a majority of us would get back in dividends more than we would pay in the tax, and all Americans would have equal incentives to transition to low-carbon ways of life. Industry would have what it needs to steer the transition: clear, unmistakable price signals to drive investment from dirty coal and imported oil to clean energy and green jobs.

Now that Republicans have taken control of the U.S. House, environmentalists are wringing their hands, seeing no possibility that Congress will enact effective climate and energy legislation in the near or distant future.

In his post-election news conference last week, President Obama all but declared cap-and-trade dead: “There are a lot of Republicans that ran against the energy bill that passed in the House last year. And so it’s doubtful that you could get the votes to pass that through the House this year or next year or the year after.”

Despite the gloom and doom, I remain optimistic that we can put a price on carbon that speeds the transition to clean energy, thereby lowering the level of greenhouse gases that cause climate change.

How can we do this with Republicans in charge of the House, given that only a handful of them voted for last year’s bill?

By coming up with a solution that does not conflict with core beliefs of the GOP. Specifically: Don’t raise people’s taxes and don’t increase the size of government.

Cap-and-trade ran afoul of both these tenets. It would have raised the cost of energy for consumers, becoming a “hidden tax.” It would have collected massive amounts of revenue to be doled out for legislators’ pet projects, and it would have established a huge bureaucracy to monitor carbon emissions and regulate a carbon trading market.

But there’s a different approach that can get the job done more effectively and remain consistent with Republican values. It goes like this:

Won’t that raise the cost of energy? Won’t people’s electric bills go up? Yes, that’s what it’s designed to do — increase the cost of energy produced by fossil fuels. And that’s why we give the revenue back to every household — so that people can afford the energy they need.